Real interest rates are nominal interest rates less inflation. Negative real rates mean if you hold cash, and often all other financial assets as well, you're actually losing purchasing power.

Negative real rates are often interpreted as a loss of confidence in the economy -- and a sign that inflation is getting out of control.

This week's release of minutes from the Fed's Aug. 5 meeting suggested more worry about the economy than did the Fed's policy statement at the time. Read related story.

But the fact that all Fed members think the next interest rate move should be up, and that a vocal minority think monetary policy is already too loose, is at least as significant.

Real interest rates have plunged abruptly and dramatically, deeper into negative territory than they've been for many years.

Our chart shows that real interest rates are already more negative than they were during the Great Stagflation of the 1970s. (And that episode, of course, lasted for several years).

Our chart also shows that real interest rates went sharply negative in the 1940s, reflecting a now-forgotten inflation spike during and after World War II.

Some of this was probably statistical noise, caused by distortions introduced by wartime price controls and by the Fed's commitment to financing the huge wartime federal deficit.

But some of it was probably due to the "monetary veil" -- the tendency of investors unused to inflation to watch only nominal interest rates and to react slowly, if at all, when inflation's insidious impact begins to be felt.

So marked is this tendency that the first edition of Sydney Homer's definitive survey, A History Of Interest Rates, first published in 1963 before the inflationary storm, did not mention the issue of nominal versus real interest rates at all.

Question: Are today's money managers, conditioned by more than two decades of positive real interest rates, ready to react quickly enough to negative rates?

Our chart also shows the astonishingly high real interest rates in the 1930s. Nominal interest rates were low in the Depression. But prices were actually falling, a result of the Federal Reserve's fatally tight monetary policy.

If real interest rates are going to remain negative, on past form it will eventually provoke an epochal shift by investors out of financial assets and into tangible assets like gold and...real estate?

Whatever happens, it's likely to be a worldwide phenomenon. Real interest rates are historically low in most major economies, if not actually negative, as in the U.S.

All over the world, central banks are trying to steer between recession and inflation.

But they are running out of road.

Edwin S. Rubenstein is president of ESR Research, Indianapolis-based consultants. See Web site.

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